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ACCT 3230: Problem Set #1 (Spring 2024)

Chap 17: Accounting for Leases (Lessee)

Earth, Inc. (lessor) and Moon Colony 2 (MC2, lessee) signed a 30-year non-cancelable lease for sky-projection equipment on December 27, 2399. The lease agreement has a January 1, 2400 commencement date and the following details:

1.   The projection equipment has an estimated economic life of 42 years.

2.   Earth, Inc. routinely leases this type of projection equipment to space colonies.

3.   The annual lease payment is $168,500, payable starting January 1, 2400 and ending with

a final payment on January 1, 2429 (for a total of 30 annual payments). MC2 (lessee) made the first payment prior to commencement of the lease on December 28, 2399.

4.   The fair value of the projection equipment at lease commencement is $2,800,000.

5.   The lease does not contain a renewal or purchase option, and the asset reverts to Earth, Inc. at the end of the 30-year lease period.

6.   The lease includes a guaranteed residual value clause, whereby MC2 (lessee) guarantees the asset will be worth at least $210,000 at the end of the lease term. MC2 expects the asset to be worth only $195,000 at the end of the lease term.

7.   The rate implicit in the lease (which is known to the lessee) is 6%. MC2’s incremental borrowing rate is 7%.

8.   MC2 is a calendar year-end space colony.

9.   MC2 was awarded a lease incentive payment of $42,000 to execute the lease, which they received in cash on December 27, 2399.

Required (from the lessee’s, MC2) perspective:

a.   Determine the appropriate lease classification.

b.   Record the entries required in December 2399 (if any) for this lease.

c.   Calculate the lease liability and the right-of-use asset at lease commencement.

d.   Prepare MC2’s journal entries for 2400 (first full year of the lease).

e.   Prepare MC2’s journal entries for 2401 (second year of the lease).

f.   Prepare MC2’s journal entries for 2429 (final year of the lease), assuming that the asset is worth $198,000 at the end of the lease term.